Emerging sectors like the cannabis industry often attract investors hoping to be among the first to capitalize on the potential growth and high returns of what they believe are untapped markets or products that may be popular in the future.
It’s true that some new sectors have been successful for some investors, such as those who invested early in internet-based companies. But the chase for the next big investment can lead investors to speculate on trends and bet on industries and products with no proven record of success.
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What is the current state of cannabis investing in Canada?
The cannabis industry has grown quickly in recent years as a number of jurisdictions, including Canada and certain U.S. states, have explored new laws around the sale and use of cannabis.
In Canada, this initially began with the legalization of cannabis for medicinal purposes. This prompted several companies to express interest in entering the market and approaching investors keen to get in on what they believed was the next big thing.
The Canadian government legalized the recreational use of cannabis in 2018. This led to many cannabis companies entering the market.
Many companies also expanded into the U.S. where some states have authorized sale and use of cannabis for medicinal or recreational purposes, even though it remains prohibited at the federal level.
Like any investment, investing in a cannabis company comes with risks that could negatively affect your investment. There remains some uncertainty in this emerging sector as business models continue to evolve.
Some investors may see others flocking toward an emerging sector and may be compelled to follow due to a fear of missing out on an opportunity. Behavioural insights has shown that investors who follow other investors’ behaviour are more likely to invest in speculative bubbles that could burst. If that happens, investors could stand to lose some or all of their investment.
Prior to the COVID-19 outbreak, cannabis companies were already starting to encounter limited access to capital. Issues such as wildfires, early freezes, and droughts due to climate change continue to impact the abilities of cannabis growers to remain competitive.
Following the COVID-19 outbreak, access to capital has become even more crucial as cannabis companies struggle with liquidity. As a result, consolidations in the cannabis industry have become increasingly common, as have bankruptcy/restructuring proceedings for cannabis companies.
Canada’s legal cannabis sector has been challenged since its inception in 2018 by the illicit market. Gaining market share has been particularly tough during the pandemic. The health crisis resulted in delays to cannabis shipments and temporary store closures, making the underground market more attractive for consumers.
The cannabis sector has taken a hit as investors re-evaluated their investments in more speculative investments.
What businesses are involved in the cannabis industry?
The rapid expansion of the cannabis industry has created opportunities for many new companies to develop products, technologies and services beyond the cultivation and distribution of cannabis itself.
Many businesses now operate under the umbrella of the cannabis industry. This includes businesses that do not actually grow or sell cannabis products directly. This makes it possible to invest in a cannabis company without investing in the cultivation or distribution of cannabis itself.
Businesses operating within the cannabis industry include:
- Agriculture technology:Businesses that support the innovation and development of equipment required to cultivate cannabis, such as automated fertilizer systems, greenhouse technologies and improved lighting systems.
- Ancillary products and services:Businesses that offer products that complement the cannabis industry. For example, products like a cannabis breathalyzer or laboratories that test cannabis products. It could also include companies that provide insurance to cultivators as well as those that create packaging for products.
- Biotechnology:Businesses that focus on the pharmaceutical applications of cannabis by developing treatments to target illnesses and diseases.
- Consulting services:Businesses that respond to the complexity of cannabis rules and regulations between different jurisdictions. They may provide services to assist with licensing, zoning or advising on operational processes.
- Consumption devices:Businesses that create products that people use to consume cannabis.
- Cultivation and retail:Businesses that grow and sell cannabis. These are the types of businesses that most people think of when discussing the cannabis industry.
- Cannabis products and extracts:Businesses that sell cannabidiol products, edibles, topicals, drinks and other products.
- Holding companies:Businesses that typically own a considerable number of voting shares in a variety of cannabis companies, allowing them to influence the management and affairs of the companies held.
- Industrial hemp:Businesses that provide products using industrial hemp, which is different than cannabis and may have numerous applications and uses, including creating consumer products like paper and clothing, as well as building materials, fuel and foods.
- Organic farms:Businesses that provide organically grown cannabis to other companies or sell to consumers directly, relying on the increasing demand for organic products and services to drive the business’s growth.
What are the risks of investing in the cannabis sector?
All investments come with some amount of risk. Generally, the higher the potential return of an investment, the higher the risk. There is no guarantee that you will actually get a higher return by accepting more risk. Learn more about the risk-return relationship.
When you invest in the cannabis industry, you’re exposed to different types of risk that can affect your potential return. Some common risks include:
No guarantee of success
Despite the rapid growth of companies in the cannabis sector, there remains no guarantee their businesses are profitable or will be in the future.
Some early, unsuccessful medical cannabis companies, failed to conduct work needed to create a profitable business. For example, providing investors with adequate disclosure about the barriers to entering the industry (such as licenses required to grow cannabis). While these disclosure requirements have been addressed by Canadian securities regulators, the risks of investing in this emerging industry remain. As with any investment, there is no guarantee that an investment in the cannabis industry will provide any return or income.
Government regulation
Frameworks for how and where cannabis products can be sold, are still being established in many of the jurisdictions that are currently exploring new cannabis laws.
For example, there may be restrictions on the stores that are permitted to sell cannabis, or rules about branding and advertising that could affect a consumer’s ability to find and purchase products. Such rules can affect a company’s ability to sell its products and make a profit, which in turn could reduce the value of your investment in the company.
As regulation continues to evolve and the cannabis industry grows, new companies will enter the industry and compete with existing cannabis businesses. Increased competition may compel a company you have invested in to adjust its business model, adjust the prices of its products, or make other changes to stay competitive. This may affect the value of your investment.
Legal considerations
Cannabis companies must abide by all the laws and regulations of the jurisdictions in which they operate, which can vary from country to country. Should laws change, the company may be required to adjust its operations to comply with the law or risk having legal action taken against it. In some cases, this may mean ending its business.
In the U.S., some states have authorized the sale and use of cannabis, but it remains illegal under federal law. Authorities in the U.S. could choose to enforce federal law at any time, putting any company with cannabis-related activities in any U.S. state at risk of being prosecuted and having its assets seized.
Investing in a company that does business in a place where the law either prohibits cannabis or is unclear about its use puts your money at risk. If legal action is taken against a company in which you have invested, you could stand to lose your entire investment.
Pricing and taxation
Government-mandated pricing and taxation on cannabis products may also pose a risk to the success of a cannabis company. Cannabis products, especially those intended for recreational use, should be priced below their black market value to attract consumers. If the government prices cannabis products too high, or if black market dealers undercut prices of products available in stores, the companies growing and selling the products may not be able to sell enough product to make a profit.
Inflated share prices
Opportunities to invest in new cannabis companies, or existing companies expanding their business into the cannabis industry, generated a high level of interest among investors looking to get in on a new trend with the expectation of quick growth. However, these investments can be highly speculative.
In some cases, companies that have simply announced their intent to develop a cannabis business have seen an immediate rise in their stock price, before there is even a viable business in place. Investors who buy shares in these companies risk paying an inflated price for an investment that may never increase in value.
Dilution
As companies scale up their operations to meet rising demand for their products, they may build larger facilities, buy additional equipment and hire additional employees. This can cost a lot of money. And, if a company doesn’t have the funds required to expand its operations, it may choose to raise money by issuing additional shares.
When companies issue additional shares to raise money, it comes at the expense of existing shareholders, whose percentage ownership decreases proportionally to the number of new shares created. This is known as dilution. If you hold shares in a company that continuously raises money by issuing more shares, your investment will decrease in value.
High operating costs
Growing and selling cannabis requires specialized and large-scale agriculture facilities and enormous amounts of power and capital, which can result in high operating costs.
As an investor, you should understand the company’s business plan and how it intends to earn a profit. You should also be aware of the related risks, costs of doing business and time it may take for the business to become profitable. There is no guarantee that a company will be successful in generating profits or increasing its stock value.
What information should you get before investing?
If you are considering investing in a cannabis company, research the opportunity and consider how the investment will help meet your financial goals. It is a good idea to:
- Review disclosure documents.Companies offering investors the opportunity to invest are required to provide specific disclosure documents, such as a prospectus, listing statement or an offering memorandum, which contains information about the business, its management, operations and business risks, including the nature of its operations in specific countries and states, as well as how it complies with laws in each jurisdiction in which it conducts business.
- Read official materials.Annual reports, management’s discussion and analysis, news releases and other official company materials can provide information about whether the company is making or losing money, information about its financial statements and comments from management on how the company has performed, as well as any industry trends or events that may have affected the company’s operations.
- Speak with an advisor.Advisors can answer questions about particular investment products and assist you with selecting investments that can help you achieve your financial goals. Find out what to expect from an advisor.
- Learn more. Explore more articles, tools and resources on getsmarteraboutmoney.ca to learn more about investing, including the risk-return relationship, understanding the exempt market and what it means to diversify your portfolio.
- Contact the Ontario Securities Commission if you have further questions or concerns. If you have a question about investing, you can contact the Ontario Securities Commission or ask us a question.
Summary
Investing in the cannabis industry has grown quickly in recent years. Investing in anything always has risks that could negatively affect your investment. There remains some uncertainty in this emerging sector as business models continue to evolve. Before investing it’s a good idea to:
- Review disclosure documents
- Read official materials about the company
- Speak with a financial advisor
- Learn more about the risk-return relationship
- Try not to allow fear of missing out or other behavioural biases motivate your investing decisions.
